The IRS has released guidance related to Code Section 965 which was added by the Tax Cuts and Jobs Act of 2017 (TCJA). Code Section 965 imposes a transition tax that calendar year taxpayers must pay with their 2017 tax returns if they have investments in certain specified foreign corporations. The guidance is provided via Frequently Asked Questions (FAQ) posted to the IRS website.

What Is the Transition Tax?

The transition tax is a one-time tax on untaxed foreign earnings of specified foreign corporations. The calculation involves an inclusion of all the untaxed earnings and profits on the U.S. shareholder’s tax return along with calculated deductions designed to reduce the effective tax rate on the inclusion to 15.5 percent on the cash portion of the earnings and profits and eight percent on the non-cash portion. C corporations also have the ability to claim a limited foreign tax credit against the transition tax amount.

Who Does This Apply to?

Code Section 965 applies to U.S. shareholders of controlled foreign corporations or U.S. shareholders of a foreign corporation that has at least one domestic corporation as a shareholder. The specified foreign corporation must have positive accumulated earnings and profits as of Nov. 2, 2017 or Dec. 31, 2017 (called a deferred foreign income corporation or DFIC). Additionally, shareholders in an S corporation that own a DFIC or partners in a domestic partnership that own a DFIC will also have a Code Section 965 inclusion and related tax calculation.

When Do I Have to Make This Payment?

The tax payment related to the transition tax is due by the due date of the tax return without extension. However, Code Section 965(h) allows for taxpayers to make an election pay the transition tax over an eight-year period with no interest.

What Is the New Guidance?

The IRS issued new guidance related to the Code Section 965 transition tax. Some of the most important items from the guidance include (but are not limited to):

An election to pay the transition tax in eight installments must be made by the extended due date of the return. However, the first installment payment must be made by the original due date of the return (without extensions).

In order to make a payment resulting from the Code Section 965 transition tax, a taxpayer needs to make two separate payments with their tax return and include two separate payment vouchers. One payment needs to reflect the tax owed on the tax return without regard to Code Section 965. The second payment needs to reflect tax owed resulting from Code Section 965. Both payments must be paid by the due date of the applicable return without extension. The Code Section 965 payment can be made by wire transfer, check, or money order.

A U.S. shareholder that has income related to Code Section 965 for the 2017 tax year is required to include with its return a Code Section 965 Transition Tax Statement. It can be attached as a PDF to an electronically filed return. The IRS has a sample statement available in the FAQ, but at a minimum it must include:

The person’s total amount of income required to be included by Code Section 965(a)

The person’s aggregate foreign cash position

The person’s total deduction available under Code Section 965(c)

The person’s deemed paid foreign taxes with respect to the income being included (for C corporations only)

The person’s disallowed deemed paid foreign taxes with respect to the income being included (C corporation only)

The total net tax liability under Code Section 965

The amount of net tax liability under Code Section 965 to be paid in eight installments

A listing of elections under Code Section 965 provided for in Notice 2018-13

In order to make an election related to the transition tax, a statement must be attached to the return and signed under penalties of perjury for each election. It can be attached as a PDF to an electronically filed return. The following elections are available:

A person that was a U.S. shareholder of a specified foreign corporation during the 2017 tax year must file a Form 5471 with respect to the specified foreign corporations.

Domestic partnerships, S corporations, and other pass-through entities that have a Section 965 income inclusion and transition tax must attach a statement to its Schedule K-1s that include the following information for each DFIC:

For individual Form 1040 filers that file electronically, they should wait to file their return on or after April 2, 2018. Individual paper filers can do so at any time. If the individual has already filed their return, they should amend the filed return to include any required statements and calculations.

In order for an S corporation shareholder to make a Code Section 965(i) election to defer the payment related to the transition tax, they must file a paper Form 1040.

The Code Section 965 calculation related to both the income inclusion and transition tax is complicated. It is important to reach out to your KSM advisor as soon as possible so this calculation can be completed.

About the AuthorRyan Miller is a partner in Katz, Sapper & Miller’s Tax Services Group. Ryan identifies innovative solutions to minimize taxes for his clients. Additionally, he oversees the international aspects of the firm’s tax practice helping companies and individuals navigate the complexities of doing business abroad.

About the AuthorKatherine Malarsky is a director in Katz, Sapper & Miller's Tax Services Group. Katherine’s focus includes analytical research and technical review of tax issues. Additionally, she assists companies and individuals in navigating the complexities of doing business abroad. Connect with her on LinkedIn.